#$gxc

BY MAULDIN ECONOMICS

Although a number of well-known hedge fund managers such as Kyle Bass and George Soros have publicly stated they believe some kind of a “hard landing” in China is coming, not everyone agrees.

Mark Yusko of Morgan Creek Capital is not in the China “hard-landing” camp. He says while the Chinese economy is facing a number of headwinds and risks as it tries to adjust to a consumer-based model, the authorities are wisely taking a balanced, long-term view.

He thinks there is a minimal risk of serious economic problems in China in the next few years.

The Western Media Is Hyping China Problems

Yusko says the biased reporting of American and European media has created major misperceptions about China on Wall Street and among the general public.

According to Yusko, the Chinese government has recently had to take a number of steps to rein in corruption and minimize asset bubbles, and this does have short-term macroeconomic consequences. He believes the Western media is doing its best to make a mountain out of what is really no more than a mid-size molehill.

Yusko offered his point of view on the Chinese economy in a recent interview with Mauldin Economics. “There have been worries about the renminbi and capital flight… I just think people are blowing out of proportion what is actually happening.”

Of interest, Yusko also suggests that while Chinese stock markets are cheap, his firm focuses more on investments in private Chinese companies. That allows them to vet the management more thoroughly, which significantly reduces the risk of fraud or corruption.

China’s Long-Term Goal Is to Make Renminbi a Gold-Backed Global Reserve Currency

Chinese policymakers are taking a long-term perspective. Yusko thinks their primary long-term goal is turning the renminbi into a global reserve currency.

He goes on to say Chinese government is looking to gold to help stabilize the renminbi and create a global reserve currency to compete with and eventually even supplant the US dollar.

According to Yusko: “Quietly, since 2013, China has become the world’s largest gold market… the PBOC (China’s Central Bank) has been buying massive amounts of gold. I believe they are moving toward a partial gold backing of the renminbi.”

Chart by www.goldchartsrus.com

Yusko, therefore, thinks that worries about a large-scale devaluation of the Chinese currency in the near future are misplaced.  He believes that the Chinese government will eventually set up a stable, “safe” currency system where the renminbi is around one-third backed by gold.

He also points to the fact the Chinese are now true global market makers for the gold market as the government has finally authorized the pricing of gold in renminbi.

“As of April 24th, the Chinese Mercantile Exchange will now price gold in renminbi. That is a huge, monster development.”

Will China Muddle through?

China has always been a conundrum. Whether you are in the “hard-landing” camp with Bass and Soros, or agree with Yusko that the Middle Kingdom will “muddle on through,” it is clear that the next year or two is a crucial transition period for the Chinese economy.

We’ll soon know if conservative economic policy and all the gold China has been hoarding will be enough to make the transition without a major hiccup.

Watch Mauldin Economics’s full interview with Mark Yusko (5:56) below for more:

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With China’s violent stock market volatility characterizing the last year, the People’s Bank of China (PBOC) did something highly unusual and seemingly unthinkable—they emailed the U.S. Federal Reserve for advice.

Last July, the PBOC’s chief, Song Xiangyan, requested the Fed share with China their playbook for Wall Street’s 1987 “Black Monday” crash. Xiangyan even asked for the information as soon as possible. The Fed responded promptly stating they would put something together.  

The email came in July of 2015 when the Chinese stock market (Shanghai Composite) tumbled from 5,166 to 3,507 in just 30 trading sessions. This occurred after their rally of more than 150% in the preceding 12 months.

As the Chinese stock market continued to tumble with losses running in the billions, and markets consequently plunging all over the world, many termed this crash "China's Black Monday," in reference to the well-known crash of 1987. The Shanghai Composite closed the month of July with a 15% decline, making it the worst month for the Chinese stock market since 2009.  

Given China’s level of pride and their desire to overtake the U.S. as a global economic superpower, their decision to reach out was surprising to say the least. But, it also speaks to just how fearful Chinese leaders were in the midst of the crisis.

So, What Advice Did the Fed Have About 1987?

You might remember it as “Black Monday,” but October 19, 1987 marked the largest one-day market crash in history. The Dow Jones lost nearly $500 billion dollars or 22.6% of its value in a matter of just few hours.

However, the Fed arguably handled the stock plunge well enough to calm the markets and prevent the economy from entering another recession or sustained bear market. In an attempt to arrest the market declines, and prevent spill-over to the broader economy, the Fed issued a statement the following morning indicating that it would support market liquidity. This was later referred to by many as “the most calming thing that was said,” considering the turbulent scenario. It was also one of the key catalysts contributing to the market rebound that morning.  

The Fed also cut the federal-funds rate from 7.5% to 7%, hoping to attract more borrowers and in turn inject liquidity in the market. Additionally, they pumped-in reserves for the next several weeks, and worked with the banks and securities firms encouraging them to further extend credit to brokers and dealers to support their liquidity and funding needs.

The Fed’s experience then proved helpful—five hours after receiving the email request from the PBOC, the Fed emailed a 259-word summary to the PBOC on how they worked to calm markets and prevent a recession.

Bottom Line for Investors

It is generally better when central banks cooperate versus not—it sends a message to global markets that the largest economies are working together to create expansionary policy and liquidity when it’s most needed. Credit markets and stock markets alike see value in such collaboration.

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In fairly clear evidence of China’s economic ‘restructuring,’ we’ve seen a pattern emerge where manufacturing activity continues to show softness while the services sector becomes more robust. Many fret over the decline in manufacturing activity in China without looking at the other side. Recent data shows the services sector expanded again in April, though at a slower pace—from 52.2 to 51.8. New business has grown at a faster pace since the beginning of the year. Meanwhile, manufacturing garners more attention, and fears were renewed when activity fell for the 14th consecutive month—from 49.7 in March to 49.4 in April. On balance, the economy should find a comfortable medium as this ‘restructuring’ occurs.

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In the past couple of years, China’s slowing growth has sold numerous headlines, but another less told story is that of the mounting debt the country is taking on to fight the “hard landing.” By some estimates, China’s total debt is estimated to stand at some $28 trillion, which means it’s nearly quadrupled over the last five to six years. You don’t have to be an economist to see that as an ‘alarming rate.’ Nevertheless, with the state owning large portions of the debt and a debt to GDP ratio just under 300%, it’s actually quite manageable and could be eradicated if China decides to shrink the balance sheet. That’s not likely to happen anytime soon, as the growing debt has been part of China’s effort to keep the economy stimulated. This story is something to keep an eye on, but in our view it still doesn’t warrant sounding the alarm. 

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Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

Steady Investor’s Week

Good News for Chinese Markets? – Chinese equities markets have been plagued by several factors, but one of the more notable ones, in our view, is the constant government meddling. First, there was the unannounced currency devaluation of around 5% last August (and another to start the New Year), and then there was the “circuit breaker” fiasco where a mechanism was implemented in equities trading to halt trading following an intraday decline of more than 5% (it failed miserably). Markets do not like to be meddled with and they especially do not like ‘surprise meddling.’ But, news this week emerged that the government is replacing Xiao Gang, who was formerly China's securities trading chief.  Maybe getting rid of the ‘bad apple’ will help un-spoil the bunch.

British Pound Takes a Pound(ing) – Britain has found itself in a rather precarious situation as it weighs whether it should remain in the European Union. Just to clarify, Britain’s membership is in the European Union – not the euro zone. The former is a unification treaty that allows for visa-less travel and open trade and labor markets – generally a good thing for capital markets and the economy. The latter (euro zone) is the currency bloc that operates under the euro and the European Central Bank, and Britain is not a part of that. Over the weekend, the British Prime Minister announced a referendum set for June 23 to vote on whether Britain stays in the union or not. Most business leaders agree that Britain should stay – isolating itself from the greater European economy would likely lead to rising costs through new trade barriers and would hurt exports. The currency, however, would potentially sustain notable collateral damage as a result of departing the European Union. A Bloomberg survey discovered that most economists believed the pound could fall to $1.35 as the vote nears. The sterling has already been bruised as fears mount over the decision, having dropped to its lowest level since March 2009 to a little under $1.40.

Meanwhile, in Greater Europe – activity in the manufacturing and services sectors hit a 13-month low in February as the euro zone composite PMI index dropped to 52.7 from 53.5 in January. This reading still signals solid expansion, which many media outlets failed to appreciate since February figures widely missed estimates and since these “13-month” lows come amid pronounced market volatility. Even still, the market took the ‘disappointing’ data as a good thing since it means that the European Central Bank may take action to stimulate the economy further in March. This reaction – when the market moves higher on disappointing news – is very similar to how U.S. markets reacted from 2011 – 2013 when the Fed considered, and eventually implemented, QE3.

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Steady Investor’s Week

Is China Spawning Global Deflation? Maybe not intentionally, but some of China’s recent actions are putting deflationary pressures on global prices. A weaker yuan is allowing China to offload excess output in steel aluminum, refined petro-products and will likely spread to basic materials and manufacturing goods. Additionally, China has been shrinking cash reserves at a fairly rapid pace, with January’s drop alone tallying $99.5B to bring their foreign currency reserves to $3.23T – the lowest level since 2012.

The Fed Doesn’t Want the Blame for Market Volatility – In a statement Wednesday, Janet Yellen seemed to concede that the economy is feeling the strain of late cycle growth pressures. She said that "financial conditions in the United States have recently become less supportive of growth." She’s likely referencing widening credit spreads, which can put a squeeze on bank lending, and the market volatility which generally makes everyone a bit uneasy. The Fed has made a habit of seemingly ‘responding’ to market volatility as though it is tied perfectly to their actions. Liquidity certainly plays a role in investment cycles, but it’s not the end all. Yellen wanted to make that message even clearer to markets by stating that market volatility is a product of a shift in global growth expectations, not necessarily U.S. interest rate policy.

European Banks Getting Slaughtered – Europe’s bank situation is much different than the U.S.’s when it comes to the Energy and oil story. Banks in Europe generally have around the same exposure to Energy and resource-sensitive loans as the U.S., but the difference is that Europe was much slower to recapitalize following the financial crisis. Since European banks generally have fewer assets than their U.S. counterparts, the Energy hit is harder on a relative basis. Even so, we don’t see the impact as being enough to spur a credit crisis in Europe (which would be devastating now given the recovery is still very fragile), but we do understand the crisis in confidence that has emerged. As the commodities story continues to play out, these banks could continue to feel the sting. Most investors should be protected from the impact on banks – a well-diversified investment portfolio shouldn’t have much European financial exposure at all.

Crude Oil May Have Further to Fall – in a meeting over the weekend, ministers from Saudi Arabia and Venezuela discussed crude oil prices, but didn’t talk too much about what everyone was hoping for: ways to provide price support. Their message appears to be to maintain the status quo for production, with no potential cuts in the works. It may help matters that Iran has stated they are willing to cooperate with OPEC when it comes to production, but that doesn’t mean a whole lot given that Iran just came online and will likely be reluctant to back off producing and selling. Supply is the big culprit in the price drop, and it doesn’t appear as though measures will be taken to reduce it in the near future.

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This week, we're starting and ending with China as there was some big retail news there and a development that may warrant a short-term "volatility alert"...

“Singles Day” Underscores China’s Resilience – for all the headlines warning of a weakening China, its retail sector proved otherwise on Wednesday. For China, “Singles Day” has turned into a major one-day shopping event, much like “Cyber Monday” here in the U.S. Alibaba Group Holding Ltd. posted a record $14.3 billion in sales on the day, with $1 billion coming in the first eight minutes of the sale. Compare this to last year’s total sales of $9.3 billion, and it’s plain to see that the consumer in China is strengthening, not weakening. Alibaba estimates that 1.7 million deliverymen, 400,000 vehicles and 200 airplanes will be utilized to deliver all the goods sold. Retail’s economic engine, at its finest.

Biggest Beer Deal in History, Formalized – the maker of Budweiser, Anheuser-Busch InBev, formalized a deal on Wednesday to buy its British-South African rival SABMiller for $107 billion. This deal has been months in the making as SABMiller played hard ball in negotiations for some time before relenting. The combined company will allow Anheuser-Busch InBev the ability to tack hard into the developing world, where SABMiller already has a significant footprint – it gets 35% of its revenue from Latin America and 34% from Africa. Molson Coors is also part of the larger deal, as they are slated to buy back SABMiller's 58% stake in their joint venture, MillerCoors, in a deal valued at $12 billion in cash. This transaction was largely done in an effort to appease regulators concerned about how big AB InBev and SABMiller would be when combined (accounting for nearly 30% of global beer sales). The deal still has a hurdle to clear in being approved by regulators.

Crude Oil Prices Looking for a Bottom – it’s near impossible to predict when oil prices will bottom out as supply and demand factors are fickle and the commodity is historically volatile. I think the $40 - $50 range probably marks the lowest they’ll go, but the International Energy Agency (IEA) published some data this week that made me second guess. According to the IEA, oil stockpiles surged to a record 3 billion barrels due to high production levels from OPEC and producers that have just recently come back online, like Iran and Libya. The IEA referred to it as a "massive cushion [that] has inflated" even as the market has recalibrated itself to just over $40 / barrel prices. With OPEC essentially refusing to cut production in an effort to provide bottom support for prices, I’d expect $40 oil to linger for a while yet. Maybe even go a bit lower in the near term.

China Mingles in the Markets (Again) with New Rules – if it feels like China is intervening in the markets every week with new rules or some kind of monetary stimulus, it’s because they are. This week, they took steps to curb leveraged bets in their stock market which arguably played a big role in creating the bubble that burst earlier in the year. This week they raised margin requirements from 50% to 100%, a rule set to take effect on November 23. I’d expect the move to stir-up some fresh volatility for the Shanghai come Monday after investors take the weekend to process the change.

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Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

Is The Market Correction Over? – the S&P 500 is less than 1% away from reclaiming its July 20 high in further evidence the selling pressure experienced in late August was a correction, not a bear market. I’ve written about this several times noting I saw the selling pressure as short-term, and for investors to keep cool, though I half expected the market to retest the correction lows. It still can, of course, but I don’t think that’s very likely at this point. The economy usually experiences a seasonal kick in Q4 and I expect that to be the case here. Seasoned investors know that when the market experiences sharp, rapid onset selling pressure with no change in fundamental data or outlook, it’s the classic sign of a correction and not the beginning of a bear market. I rather enjoy watching the media make hysteria over a market event that, trend-wise, is actually a very normal and healthy part of bull markets. It helps keep a solid foundation in that wall of worry bull markets love to climb.

M&A Record Year Likely (Again) – investors often get lost in the mire of Fed watching, worries over China, concerns over cratering commodities prices and geopolitical issues like the fight against ISIS. At any given time, the global economic and investment picture can look rather bleak. My advice: when the confluence of fears gets you down on stocks, remember where to keep your focus – U.S. Corporations. And just like that, optimism sets back in. Corporations have been busy growing record earnings (ex-Energy), buying back shares with the record amounts of cash they have on hand, and swallowing up peers in M&A deals.  Right now, these deals are on pace to hit $4.5 trillion for 2015. That’s trillion, folks. 2015 is set to eclipse the $4.3 trillion year had in 2007, with Health Care notably the busiest sector.

Bank of England’s “Super Thursday” – the Bank of England voted 8-1 to keep interest rates steady at 0.5%, marking its 7th consecutive year without a rate hike. The U.K. enjoyed the best GDP growth rate among ‘developed’ countries last year, having expanded by 2.6% compared to the U.S.’s 2.4% clip. Both central banks are moving too slow to commence their respective rate hike cycles, in my view, so when they do finally commence in the near future it should not adversely impact future growth in a major way. The BOE is almost certainly taking their cues from the Fed, so I don’t expect a rate increase in England until we see one here.  

Chinese Projections Subject to Change – In a speech this week, Xi Jinping declared a goal to have China’s annual growth not dip below 6.5% over the next five years in order to realize its economic goals by 2020. China also laudably continues pressing forward with goals of economic reform, even amidst concerns over growth and the market’s impatience with what could be a ‘new normal’ for China. I see it as a positive. The more China opens their economy to market forces versus state-run spending and investment programs, the better chance it has of creating a long-term path to stability. In a sign of more willingness on that front, China announced it would further open its markets to foreign investment by establishing a trading link between Shenzhen and Hong Kong by the end of the year. This is key to attaining more market participants and confidence in the functionality and efficiency of equities markets, and would help China convince MSCI to allow it entry into developed world indices. Quietly, Chinese equities have been staging a strong comeback amidst all this news (though the media barely reports it). The Shanghai Composite is up over 20% from an August low.

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Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.